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Thursday, October 28, 2010

Does this roller-coaster go down too?

It looks like the silver roller-coaster ride is just going up a steep incline but will it ever have that scary drop straight down into the abyss? Based on the ride of the past 5 years it doesn't appear so. Before 2005, you could count on a constant price of silver being in the $5-$7 range with a few outlying events. Since that time, the price of silver has risen from $7 up to $24 (3.5 times or a 243% increase). The reason for the constant rise may be based on the establishment of the Silver ETF.

In 2005, Barlays Global Investors made plans to establish a Silver Exchange Traded Fund (ETF) which was based on the successful Gold ETFs that first debuted in 2004. For the Silver ETF, each share of the Silver ETF represents 10 ounces of real silver that Barclays must purchase and hold in a vault. When Barclays proposed the Silver ETF, the non-profit Silver Users Association was opposed to the ETF on the basis that it would take a large amount of silver off of the open market and push up prices. Based on the history of the past 5 years, it appears that their forecast is correct. Barclays had to start buying the reserves they needed for the ETF in 2005 so with the approval from the SEC (Securities & Exchange Commission), they were able to launch the Silver ETF in April of 2006. At that point, with Barclays buying so much silver for their reserves, the price of silver had already climbed from $7 in 2005 to $12 in 2006. The month the ETF debuted, silver went from $12 to $15 (25% increase in one month).

We are now at the mercy of speculators (some say investors) rather than actual silver end-users. Within 2 years of the debut of the Silver ETF, the price of silver had gone to over $20, almost doubling the price from the ETF debut and three times the historical price. As mentioned previously, you count historically count on a constant pricing of silver in the $5-$7 range. Since the debut of the ETF, we start to see a wild swing in the price. In 2008, silver dropped back down to below $10, a drop over over 50% in a matter of months. In 2009 it rose back up, almost hitting the $20 mark again but this time it was a slower and steadier climb with fewer wild swings in the price. It rose with higher highs and higher lows and finished 2009 just below $18/oz. In 2010, it dropped slightly to $16/oz to the start the year but then gradually climbed to the present price of $24/oz.

However, even at $24 we are still 50% below the all-time high price of silver. The silver market has been at the hands of speculators before. Back in the late 1970's, the Hunt Brothers tried to corner the market on silver, driving it to the all time high of $49.45 in 1980. At height of their buying, they held 1/3 of the world's private market(sellable) silver, thus restricting the available amount for sale on the open market. The Hunt Brothers' hoarding of the silver and purchase on the open market caused the price to go from $6/oz to almost $50/oz. Tiffanys ran a full-page ad in the New York Times condemning the Hunt Brothers and the rules that allow them to manipulate the market. After changes to the trading rules on the Comex (Commodity exchange) in regards to buying on margin, the Hunt Brothers were facing margin calls on their purchases and were forced to sell and market panic ensued. The market dropped down to $11 and gradually returned to the historic $6 range.

Another factor in the current rise in silver prices is the increased use of silver in electronics and manufacturing, not to mention the increase availablity of silver jewelry. Since silver has the highest electrical conductivity of any element and the highest thermal conductivity of any metal, silver is used widely in manufacturing. Some of the applications using silver include computers, batteries, mirrors, stereo equipment, music instruments, photography, medicinal equipment, etc. It is also used for silverware utensils, jewelry, anti-microbial applications, etc.

Some say the uncertainty in the economy and the uncertainty of the long-term strength of the dollar is what is currently driving people to buy more gold and silver. Some say it is the usual market speculation - people looking to make a quick dollar. Some say it is the increased use of silver in electronics, manufacturing, and jewelry. I think a major part of the current price is that we now have at least 14 Silver ETFs - 6 in America, 3 in Canada, and 5 in England. With each ETF having to buy physical silver that represents each share sold, we now have Hunt Brothers style hoarding of silver. Combine that with the other factors and it seems like this roller-coaster might continue on it current path upward.